The Dark Side Of Crowdfunding

Though it sounds like a great new idea, crowdfunding comes with its own pitfalls. Bidness Etc, in its follow-up article on the subject, explores how it can go wrong

Many analysts consider crowdfunding the next big disruption in the investment landscape. Boasting cutting edge advantages like improved transparency, the democratization of the fundraising processes, and lesser red tape for lenders and borrowers alike, it is no wonder that crowdfunding is rapidly gaining global traction.

In 2013, companies of various scales and sizes raised $5 billion through this channel, nearly double what they had raised in 2012. With the SEC currently working on a set of regulations that will allow even non-accredited investors (individuals with a net worth of less than $1 million) to participate in crowdfunding platforms, this new paradigm seems all set to effect some serious changes.crowdfunding marketing

But before you think you can use crowdfunding to raise easy money for your brilliant idea, or donate money to support a brilliantly-phrased business plan, you need to grasp its shortfalls.crowdfunding advertising

The Inconvenient Truth: Most Startups Fail

The ease with which some companies can suction money out of the pockets of naïve investors poses an interesting problem. Companies can hype their products or use lofty sales projections to impress an investor who has little to no knowledge about the business and the industry at large, and does not have the experience, time, resources, or willingness to dig for more information like a venture capital (VC) firm would before pouring money into a business.indiegogo marketing

As a result, crowdfunding is, to a great extent, likely to fund companies that have poor business models and are therefore likely to fail. VCs, in comparison, will use their decades of experience in funding related businesses to pinpoint even the finest of loopholes and pitfalls in a business plan. And still, three of every four startups VCs will fund will fail to emerge as established businesses, according to a study conducted by Harvard Business School lecturer Shikhar Ghosh.kickstarter marketing

It Is Hard To Sell Technical Funding Needs To Unsophisticated Investors

Try selling a sophisticated software application idea to a technologically-challenged, but wealthy individual. Beyond confused looks, expect a litany of questions and an eventual refusal to fund the project.

Crowdfunding may attract a larger pool of investors, but the likelihood that you’ll see any of their money reduces drastically once you start getting into the technical stuff. These investors are, after all, largely laymen, and as such will have unrealistic expectations from their investments.kickstarter project

So if it’s a non-tangible high-tech product you are looking to disrupt a market with, an institutional investor, an investment bank, or a VC is who you should be looking to for your financial needs.

Moreover, even existing companies with non-technical product offerings can find it hard to convince investors on crowdfunding platforms. The New York City opera, which was founded in 1943, marked a famous crowdfunding failure when it announced in September last year a desperate need for $20 million to fund productions for the 2013/2014 season. One of the other sources it used to raise funds was the popular crowdfunding platform, Kickstarter, where it sought $1 million. However, investors pledged only $301,000. The New York City opera eventually filed for bankruptcy in October 2013.CrowdFunding advertizing

You May Lose Your Shirt In Public

A self-funded private company may have the luxury to flop without agitating investors, and a startup funded by a VC is answerable only to its primary lender – the VC itself. The failure of a crowdfunded business, however, can easily be followed by a vocal whiplash from thousands of investors who may have bought into the lofty claims made by the company during the fundraising process.

Most importantly, the increased transparency in crowdfunding also brings with it the disadvantage of increased visibility of the funding process. A failed attempt to raise funds can severely constrain a venture’s chances of raising funds in the future not only through the crowdfunding channel, but also through channels like VC firms and institutional investors.Kickstarter Marketing

Crowdfunding Is Often Only A Final Option

A business idea with a genuine, truly “disruptive” edge, or a cash-strapped private company with quite a few big things in the works will hardly want to bypass professional VCs or savvy institutional investors and instead take the shady and messy route of approaching “crowds” to raise funds.

Those that do use crowdfunding may lack a foolproof business plan, or may indeed lack the kind of evidential reasoning to back claims that convince mainstream lenders. Approaching unsophisticated masses then becomes the last real option for such companies.Indiegogo Marketing

Subsequent Funding Drives May Face Problems

Even if some companies do manage to meet their initial financing needs by crowdfunding, subsequent fundraising rounds can prove more difficult. It is difficult to get investors to dip once again into their pockets, and convincing a whole new group of laymen can be a daunting task in itself.

Furthermore, mainstream lending options may be limited for crowdfunded businesses, as VCs generally associate such ventures with the unprofessional image crowdfunded businesses usually portray.crowdfunding websites

Conclusion

Despite the massive growth in crowdsourcing, the channel’s ability to disrupt the investment landscape severely remains limited. It seems slightly far-fetched to think that crowdfunding alone can give the investment banking industry a tough time, as some analysts have started to think.

Yes, crowdfunding does bring large crowds of investors; and with even non-accredited investors set to feature in the crowdfunding space, new and varied investment options have made fundraising easier for private companies. However, the fact that mainstream lending-borrowing transactions do not involve unsophisticated crowds or public websites will essentially cap the channel’s disruptive ability. That said, it nevertheless remains an attractive catalyst for innovation and a forum for experimentation for budding entrepreneurs.ut also through channels like VC firms and institutional investors.CrowdFunding advertizing